Emerging market hedges funds has a net withdrawal of $1.5 billion in the second quarter, the second consecutive quarter that it has experienced a net capital withdrawal.

Combining second quarter outflows with performance-based losses, total capital invested in emerging market hedge funds dropped by $3.2 billion, ending the quarter at a little under $95 billion, according to data released by Hedge Fund Research. It was the seventh quarter in the last eight in which EM hedge funds have experienced a net capital withdrawal.

Emerging market investors allocated new capital to hedge funds focused on Latin America and the Middle East, while redemptions were concentrated in Russia and Emerging Asia, according to the Hedge Fund Research figures. Overall the hedge fund industry experienced a capital inflow of $9.6 billion for the second quarter, and a first half capital inflow of $23 billion. Meanwhile, along with redemptions in excess of $550 million in the first quarter, investors have withdrawn over $2 billion from emerging market hedge funds in the first half of 2010.

“Emerging markets are having a little slower of a time at recovery,” said Kenneth Heinz, president of Hedge Fund Research. “Flows have been running at about 20% of 2007. It’s not a huge amount going out; it’s just not coming in like the rest of the industry.”

Although emerging markets have experienced anemic performance in the near-term, Heinz said if investors look at the performance over the long term they should have more confidence about the sector going forward. He expects to see to more capital going into emerging markets in the next quarter. One of the things holding investors back has been the prospects how financial reform would impact the hedge fund industry. Over the last two months, the implications have become clearer. Another factor has been the fact that over the last couple of years people have been investing to avoid risk, not generate returns. Heinz expects that to begin changing.